# What Constitutes a "Commercially Reasonable" Procedure for Valuing a Terminated Derivative? ▴ Question

**Published:** 2025-08-04
**Categories:** Question

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## Concept

The abrupt termination of a derivative contract, whether through counterparty default or another trigger event, creates an immediate and critical operational challenge. The central question is no longer about the future performance of the instrument but about its present value in a state of disruption. Determining what constitutes a “[commercially reasonable](https://prime.greeks.live/area/commercially-reasonable/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)” procedure for valuing this [terminated derivative](https://prime.greeks.live/question/in-what-ways-can-the-valuation-of-terminated-derivatives-be-disputed-during-a-default/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) is a function of establishing a defensible, transparent, and market-grounded process to arrive at a fair close-out amount.

This standard is a procedural backstop, a system designed to ensure fairness and predictability when the ordinary course of business has failed. Its architecture is built upon a foundation of legal precedent and market convention, primarily codified within the International Swaps and Derivatives Association (ISDA) [Master Agreement](https://prime.greeks.live/area/master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite).

The evolution of market standards reveals the system’s logic. The 1992 [ISDA Master Agreement](https://prime.greeks.live/area/isda-master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) presented two primary valuation pathways ▴ “Market Quotation” and “Loss.” Market Quotation was a rigid, formulaic approach requiring the solicitation of quotes for a [replacement transaction](https://prime.greeks.live/area/replacement-transaction/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) from a pre-defined set of “Reference Market-makers.” Its strength was its objectivity, but its rigidity became a weakness in illiquid or stressed markets where obtaining sufficient quotes was impractical. The alternative, “Loss,” was a more flexible but subjective measure, allowing the non-defaulting party to calculate its total economic damages in good faith. This flexibility often led to disputes over the methods and inputs used.

> A commercially reasonable valuation is defined by the integrity of its process, not solely by the final number it produces.

Recognizing these limitations, the [2002 ISDA Master Agreement](https://prime.greeks.live/area/2002-isda-master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) introduced a unified, more sophisticated standard known as the “Close-out Amount.” This framework represents the current institutional benchmark. It requires the calculating party to act in good faith and use [commercially reasonable procedures](https://prime.greeks.live/area/commercially-reasonable-procedures/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) to determine the losses or costs associated with replacing the economic equivalent of the terminated transaction. This standard explicitly allows for the inclusion of related costs, such as the expense of unwinding or re-establishing hedges and the cost of funding.

The shift from the older methodologies to the [Close-out Amount](https://prime.greeks.live/area/close-out-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) reflects a fundamental understanding ▴ in complex, often illiquid OTC markets, a single, rigid valuation formula is inadequate. A robust and adaptable process, one that can accommodate different market conditions and instrument types while adhering to clear principles of fairness and transparency, is the superior architecture.

This procedure is therefore a system of ordered, logical steps designed to withstand scrutiny. It operates on the principle that if the process is sound, the outcome is defensible. The core components of this system include the consistent application of valuation methodologies, diligent documentation of every decision and data point, and the use of inputs that are verifiable and rooted in observable market practice wherever possible.

In a bankruptcy context, this procedural rigor is even more critical, as legal frameworks like the U.S. Bankruptcy Code’s Section 562 place the burden of proof on the calculating party to justify its valuation timing and methodology. Ultimately, a [commercially reasonable procedure](https://prime.greeks.live/question/what-constitutes-a-commercially-reasonable-procedure-in-a-close-out-scenario/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) is one that a disinterested third party, such as a court or an arbitrator, can examine and find to be a logical, fair, and well-documented effort to replicate the economic reality of the terminated derivative at a specific moment in time.

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## Strategy

Developing a strategy for valuing a terminated derivative centers on constructing a valuation process that is both methodologically sound and procedurally defensible. The overarching goal is to arrive at a “Close-out Amount” that accurately reflects the economic reality of the non-defaulting party’s position, as prescribed by the 2002 ISDA Master Agreement. This requires a clear strategy for selecting valuation inputs, applying appropriate methodologies, and navigating the linked duties of [good faith](https://prime.greeks.live/area/good-faith/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) and [commercial reasonableness](https://prime.greeks.live/area/commercial-reasonableness/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite).

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## A Hierarchy of Valuation Inputs

A core strategic principle is the adoption of a [valuation hierarchy](https://prime.greeks.live/area/valuation-hierarchy/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite), similar to the framework used in financial accounting standards like IFRS 13 or ASC 820. This hierarchy prioritizes observable, market-based inputs over unobservable, model-based ones, creating a cascade of preferred data sources.

- **Level 1 Inputs** ▴ These are the most reliable and constitute the primary strategic objective to obtain. They are quoted prices in active markets for identical assets or liabilities. For a terminated derivative, this would be a firm, executable quote from a reputable dealer to enter into a replacement transaction that is the precise economic equivalent of the terminated one. Sourcing multiple such quotes provides the strongest possible evidence of a fair value.

- **Level 2 Inputs** ▴ When direct quotes for an identical transaction are unavailable, the strategy shifts to using observable inputs for similar instruments. This could involve using the price of a more liquid, standard derivative and then applying adjustments for differences in tenor, optionality, or underlying reference. It might also include using interest rate curves, volatility surfaces, or credit default swap (CDS) spreads from active markets to feed into a valuation model. The key is that the inputs themselves are sourced from the market, even if the final value is a product of a calculation.

- **Level 3 Inputs** ▴ This is the recourse when observable market data is scarce or non-existent, a common situation for highly structured or long-dated derivatives, or during periods of extreme market dislocation. The strategy here relies on internal valuation models, such as a Discounted Cash Flow (DCF) analysis. Using Level 3 inputs requires the highest degree of transparency and justification. Every assumption, from future cash flow projections to the discount rate applied, must be documented and defended as commercially reasonable.

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## Methodological Approaches to the Close out Amount

The strategy for calculating the Close-out Amount must be flexible enough to accommodate the available inputs. The [2002 ISDA](https://prime.greeks.live/area/2002-isda/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) framework is designed to support this flexibility, focusing on the economic outcome.

The primary method is determining the **[Replacement Cost](https://prime.greeks.live/area/replacement-cost/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)**. This involves actively soliciting bids from market-makers to enter into a new transaction that mirrors the material terms of the terminated one. A sound strategy involves contacting a representative sample of leading dealers in that specific market segment (e.g.

3-5 dealers) and documenting their responses, even if they decline to quote. Firm bids are superior to indicative quotes, as they represent an actual price at which a transaction could be executed.

When replacement is not feasible, a **[Model-Based Valuation](https://prime.greeks.live/area/model-based-valuation/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)** becomes the core of the strategy. A DCF model, for instance, is often considered commercially reasonable for valuing income-producing assets like a portfolio of loans underlying a repurchase agreement. The strategy here is to ensure the model’s integrity. This means using industry-standard models, sourcing inputs from the highest available level in the valuation hierarchy, and having the model’s output independently verified by an internal risk or valuation control group.

> The strategic shift from the 1992 ISDA’s rigid formulas to the 2002 ISDA’s process-oriented standard acknowledges that in derivatives valuation, the ‘how’ is as important as the ‘what’.

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## Comparing ISDA Valuation Methodologies

Understanding the evolution of the ISDA Master Agreement’s valuation standards clarifies the strategic intent behind the current “Close-out Amount” framework. The table below compares the key methodologies, highlighting the deliberate move towards a more flexible, process-driven approach.

| Feature | 1992 ISDA Market Quotation | 1992 ISDA Loss | 2002 ISDA Close out Amount |
| --- | --- | --- | --- |
| Core Concept | Calculated average of quotes solicited from pre-agreed Reference Market-makers for a replacement transaction. | A determination of the non-defaulting party’s total losses and costs resulting from the early termination. | The total losses or costs incurred in replacing, or providing the economic equivalent of, the terminated transaction. |
| Procedural Standard | A highly prescriptive, formulaic calculation based on obtaining a specific number of quotes. | The non-defaulting party must determine its Loss “reasonably” and “in good faith.” | The determining party must “act in good faith and use commercially reasonable procedures.” |
| Flexibility | Very low. The process is rigid and can fail if insufficient quotes are obtained. | Very high. This subjectivity can lead to disputes over the reasonableness of the calculation. | High but structured. It provides flexibility while demanding a defensible and transparent process. |
| Included Costs | Generally limited to the replacement cost itself, without explicit mention of ancillary costs. | Broadly defined, allowing for a wide interpretation of what constitutes a “loss.” | Explicitly includes the costs of funding and the costs of terminating or re-establishing any related hedges. |
| Market Application | Previously a common choice but now largely superseded due to its inflexibility in stressed markets. | Historically used as a fallback or for complex derivatives where Market Quotation was impractical. | The current, dominant market standard for most new OTC derivative transactions. |

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## What Is the Role of Good Faith?

A critical element of the strategy is understanding the interplay between “good faith” and “commercially reasonable procedures.” They are intertwined obligations. Good faith is a subjective standard, relating to the state of mind and intentions of the calculating party ▴ it is a duty to act honestly. Commercial reasonableness, conversely, is an objective standard. It assesses the actions taken against the norms and practices of participants in the relevant market.

A strategy cannot rely on good faith alone. A party could honestly believe its valuation is correct, but if the procedure used to arrive at that valuation deviates from standard market practices without justification, it would fail the commercial reasonableness test. The strategy must therefore be to ensure that every step of the process is not only performed honestly but is also aligned with what a reasonable market participant would do in similar circumstances.

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## Execution

The execution of a commercially reasonable valuation is a meticulous, time-sensitive operational procedure. It translates the strategic framework into a series of documented, verifiable actions. The objective is to produce a final Close-out Amount that is robust enough to withstand a potential legal or regulatory challenge. This requires a disciplined playbook, rigorous data management, and a clear understanding of how the process adapts to specific contexts like bankruptcy.

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## The Operational Playbook for Calculating the Close out Amount

Executing the valuation requires a step-by-step process where each stage is carefully documented. This playbook ensures consistency and creates an audit trail that serves as the primary evidence of a commercially reasonable procedure.

- **Activation and Documentation Assembly** ▴ The process begins the moment an [Early Termination Date](https://prime.greeks.live/area/early-termination-date/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) is designated. The first action is to secure and assemble all relevant documentation. This includes the signed ISDA Master Agreement, the trade confirmation for the terminated transaction(s), any collateral agreements, and a complete record of all related cash flows and communications.

- **Designation of Valuation Date and Time** ▴ The ISDA Master Agreement specifies that the valuation should occur as of the [Early Termination](https://prime.greeks.live/area/early-termination/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) Date. If market conditions (e.g. extreme illiquidity, market closure) make a valuation on this date impossible or unreliable, a subsequent date may be used. The execution of this step requires a formal, documented decision explaining why the original date was not commercially reasonable.

- **Valuation Team Mobilization** ▴ A cross-functional team should be formally assigned to the task. This team typically includes personnel from the trading desk with product expertise, the risk management or valuation control group for independent oversight, and the legal department to ensure compliance with the contractual terms. For highly complex valuations, engaging an independent third-party valuation expert may be a key part of the execution.

- **Execution of Primary Valuation Sourcing Market Quotes** ▴ The team’s first attempt should be to source executable quotes for a replacement transaction. This involves a formal, documented Request for Quote (RFQ) process sent to a list of 3-5 leading dealers in the relevant derivative market. The RFQ must specify the precise economic terms of the required replacement trade. All responses, including declinations to quote, must be logged with timestamps.

- **Execution of Secondary Valuation Model Based Approach** ▴ If an insufficient number of firm quotes is obtained, the playbook dictates a shift to a model-based valuation. The execution requires selecting an industry-standard valuation model (e.g. a proprietary DCF model, or a standard option pricing model like Black-Scholes). The model choice itself must be justifiable and documented.

- **Input Calibration and Justification** ▴ This is the most data-intensive step. Every input into the model must be sourced, documented, and justified. This includes market data like yield curves and volatility surfaces, and credit data like counterparty credit spreads. The source for each input (e.g. Bloomberg, Reuters, Markit) should be recorded. For unobservable inputs (Level 3), a detailed narrative explaining their derivation is required.

- **Calculation of Adjustments and Ancillary Costs** ▴ The execution must include the calculation of all permissible adjustments under the 2002 ISDA definition of Close-out Amount. This includes:

<li>**Credit Valuation Adjustment (CVA)** ▴ To reflect the credit risk of the counterparty.

- **Funding Valuation Adjustment (FVA)** ▴ To incorporate the cost of funding the replacement trade.

- **[Hedging Costs](https://prime.greeks.live/area/hedging-costs/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite)** ▴ The documented costs of terminating, liquidating, or re-establishing any hedges related to the terminated derivative.

</li>
- **Independent Review and Verification** ▴ The completed valuation, including all methodologies, inputs, and adjustments, must be submitted to an independent internal function for review and approval. This could be a dedicated [Price Verification](https://prime.greeks.live/area/price-verification/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite) (IPV) team or a senior risk committee. This step provides a critical layer of internal control and objectivity.

- **Final Report Generation** ▴ The final output of the execution is a comprehensive valuation report. This report serves as the definitive record of the process. It should detail the final Close-out Amount, the methodology used, a log of all quotes solicited, a complete list of all model inputs and their sources, and the sign-off from the independent review team.

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## Quantitative Modeling and Data Analysis

The credibility of a model-based valuation rests entirely on the quality and transparency of its data. The following tables provide examples of the granular documentation required during the execution phase.

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## How Should Valuation Inputs Be Documented?

The following table illustrates a sample log for the inputs used to value a hypothetical 10-year US Dollar interest rate swap that has been terminated.

| Input Parameter | Source | Value / Reference | Justification for Source and Value |
| --- | --- | --- | --- |
| Valuation Date | Internal Decision Log | 2025-08-04 16:00 UTC | Designated Early Termination Date as per notice. Market was liquid at this time. |
| USD SOFR Curve | Bloomberg Terminal (SWPM) | Curve ID ▴ C075 | Industry standard source for institutional swap valuation. Curve bootstrapped from active futures and swaps. |
| Counterparty Credit Spread | Markit CDS Data | 310 bps (5-year tenor) | Based on the average of CDS spreads for a peer group of similarly rated entities, as the counterparty itself is not actively traded. |
| Funding Spread | Internal Treasury Desk | SOFR + 65 bps | Represents the firm’s verified, all-in cost of funds for a collateralized transaction of this tenor and risk profile. |
| Hedge Unwind Cost | Execution Log #78910 | $45,200 | Actual loss realized on the liquidation of a portfolio of Treasury futures used to hedge the swap’s interest rate risk. |

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## Why Is a Quote Solicitation Record Important?

This record demonstrates a good-faith effort to obtain market-based prices, which is a cornerstone of a commercially reasonable process.

The following table shows a hypothetical log of attempts to get a replacement quote.

| Dealer Contacted | Time of Contact (UTC) | Response Type | Quoted Price (Payable by Us) | Notes and Justification |
| --- | --- | --- | --- | --- |
| Global Bank A | 14:32 | Indicative Quote | $3,100,000 | Provided for guidance only. Desk cited market volatility and was unwilling to provide a firm, executable price. |
| Investment Bank B | 14:35 | Firm Quote (valid 2 mins) | $3,250,000 | Executable bid received via electronic platform. Quote expired before it could be acted upon while awaiting other quotes. |
| Securities Firm C | 14:38 | Decline to Quote | N/A | Trader stated they had reached their risk limit for that counterparty sector for the day. Email confirmation saved. |
| European Bank D | 14:45 | Indicative Quote | $3,050,000 | Based on their internal model’s end-of-day run. Not an executable price. Used as a cross-check for our own model. |

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## What Is the Impact of a Bankruptcy Filing?

When a counterparty enters bankruptcy, the execution of the valuation process is subject to additional legal constraints and scrutiny, primarily under the U.S. Bankruptcy Code. Section 562 establishes the timing for measuring damages from a terminated swap agreement. Damages are to be measured as of the date of termination. However, the statute provides a critical exception ▴ if there are no “commercially reasonable determinants of value” on that date, damages are measured on the first subsequent date where such determinants exist.

This provision places an immense burden of proof on the party that performed the valuation. If a debtor or trustee challenges the valuation date, the non-defaulting party must be able to prove, using evidence like the quote solicitation record, that it was impossible to obtain a reliable value on the termination date. This makes the disciplined execution of the operational playbook and the meticulous documentation of every failed attempt to get a price absolutely critical for defending the valuation in court.

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## References

- Ashurst. “BRRD ▴ valuation of derivatives and contractual stays in financial contracts.” Ashurst, 2014.

- Schotz, Cole. “What Does ‘Commercially Reasonable Determinants of Value’ Mean Under Section 562 of the Bankruptcy Code?” Cole Schotz, 27 July 2010.

- Tucker, Paul, and Charles Smithson. “Valuation in the context of derivatives litigation.” Capital Markets Law Journal, vol. 6, no. 3, 2011, pp. 344-356.

- Jones Day. “DCF Analysis ▴ A ‘Commercially Reasonable Determinant’ of Value for Liquidation of Mortgage Loans in Repo Transaction.” Jones Day, August 2011.

- Clifford Chance. “Financial Collateral Arrangements ▴ Valuing Collateral in a ‘Commercially reasonable manner’.” Clifford Chance, 1 November 2022.

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## Reflection

The principles and procedures discussed form a robust system for valuing a terminated derivative. The framework, built on the foundation of the ISDA Master Agreement and reinforced by legal precedent, provides a clear path for navigating a complex and high-stakes event. Yet, the existence of this framework is only the first component.

The true test of an institution’s preparedness lies in its internal operational architecture. How is this system embedded within your own firm’s protocols?

Consider the state of your own valuation playbook. Is it a theoretical document, or is it a living procedure, pressure-tested through drills and understood by all relevant personnel across trading, risk, and legal? When a termination event occurs, the response must be automatic and precise. The time for designing the system is long past; the only variable should be its execution.

Reflect on the data infrastructure that supports your valuation process. Is your ability to capture, timestamp, and archive every quote, every model input, and every internal decision sufficient to construct an unassailable audit trail? A valuation’s defense in a dispute is built not on recollection, but on records.

Ultimately, mastering the valuation of terminated derivatives is a reflection of a firm’s overall operational mastery. It demonstrates a commitment to process, a respect for transparency, and an understanding that in moments of market stress, a defensible procedure is the ultimate strategic asset. The knowledge of what constitutes a “commercially reasonable” procedure is the blueprint; the strength of your internal systems determines the integrity of the final construction.

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## Glossary

<a href="https://prime.greeks.live/area/commercially-reasonable/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Commercially Reasonable

Meaning ▴ "Commercially Reasonable" is a legal and business standard requiring parties to a contract to act in a practical, prudent, and sensible manner, consistent with prevailing industry practices and good faith. </a><a href="https://prime.greeks.live/question/in-what-ways-can-the-valuation-of-terminated-derivatives-be-disputed-during-a-default/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Terminated Derivative

Disputing a terminated derivative's value involves a forensic audit of the close-out process and its commercial reasonableness. </a><a href="https://prime.greeks.live/area/master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
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## Master Agreement

Meaning ▴ A Master Agreement is a standardized, foundational legal contract that establishes the overarching terms and conditions governing all future transactions between two parties for specific financial instruments, such as derivatives or foreign exchange. </a><a href="https://prime.greeks.live/area/replacement-transaction/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![Sleek, intersecting planes, one teal, converge at a reflective central module. This visualizes an institutional digital asset derivatives Prime RFQ, enabling RFQ price discovery across liquidity pools](https://options.greeks.live/wp-content/uploads/2025/07/prime-os-digital-asset-derivatives-rfq-engine-optimizing-institutional-liquidity-aggregation-and-best-execution.jpg)

## Replacement Transaction

Meaning ▴ A Replacement Transaction in crypto refers to the execution of a new trade or contract designed to supersede or nullify the financial exposure of a previously initiated, often failed or unfulfilled, digital asset transaction. </a><a href="https://prime.greeks.live/area/isda-master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A complex central mechanism, akin to an institutional RFQ engine, displays intricate internal components representing market microstructure and algorithmic trading. Transparent intersecting planes symbolize optimized liquidity aggregation and high-fidelity execution for digital asset derivatives, ensuring capital efficiency and atomic settlement](https://options.greeks.live/wp-content/uploads/2025/07/institutional-rfq-engine-optimizing-digital-asset-derivative-execution.jpg)

## Isda Master Agreement

Meaning ▴ The ISDA Master Agreement, while originating in traditional finance, serves as a crucial foundational legal framework for institutional participants engaging in over-the-counter (OTC) crypto derivatives trading and complex RFQ crypto transactions. </a><a href="https://prime.greeks.live/area/commercially-reasonable-procedures/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A central institutional Prime RFQ, showcasing intricate market microstructure, interacts with a translucent digital asset derivatives liquidity pool. An algorithmic trading engine, embodying a high-fidelity RFQ protocol, navigates this for precise multi-leg spread execution and optimal price discovery](https://options.greeks.live/wp-content/uploads/2025/07/prime-os-rfq-protocol-navigating-digital-asset-derivative-liquidity.jpg)

## Commercially Reasonable Procedures

Meaning ▴ Commercially Reasonable Procedures denote a standard of conduct or a set of actions that a prudent and competent entity would undertake in a specific business context, balancing cost, effectiveness, and prevailing industry practices. </a><a href="https://prime.greeks.live/area/2002-isda-master-agreement/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A transparent glass sphere rests precisely on a metallic rod, connecting a grey structural element and a dark teal engineered module with a clear lens. This symbolizes atomic settlement of digital asset derivatives via private quotation within a Prime RFQ, showcasing high-fidelity execution and capital efficiency for RFQ protocols and liquidity aggregation](https://options.greeks.live/wp-content/uploads/2025/07/architecting-high-fidelity-execution-for-institutional-digital-asset-derivatives-rfq-protocols-and-systemic-liquidity-aggregation.jpg)

## 2002 Isda Master Agreement

Meaning ▴ The 2002 ISDA Master Agreement is the foundational legal document published by the International Swaps and Derivatives Association, designed to standardize the contractual terms for privately negotiated (Over-the-Counter) derivatives transactions between two counterparties globally. </a><a href="https://prime.greeks.live/area/close-out-amount/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A marbled sphere symbolizes a complex institutional block trade, resting on segmented platforms representing diverse liquidity pools and execution venues. This visualizes sophisticated RFQ protocols, ensuring high-fidelity execution and optimal price discovery within dynamic market microstructure for digital asset derivatives](https://options.greeks.live/wp-content/uploads/2025/07/principal-rfq-aggregation-digital-asset-derivative-execution-optimization.jpg)

## Close-Out Amount

Meaning ▴ The Close-Out Amount represents the aggregated net sum due between two parties upon the early termination or default of a master agreement, encompassing all outstanding obligations across multiple transactions. </a><a href="https://prime.greeks.live/question/what-constitutes-a-commercially-reasonable-procedure-in-a-close-out-scenario/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![Stacked, glossy modular components depict an institutional-grade Digital Asset Derivatives platform. Layers signify RFQ protocol orchestration, high-fidelity execution, and liquidity aggregation](https://options.greeks.live/wp-content/uploads/2025/07/layered-digital-asset-derivatives-rfq-protocol-stack-for-prime-brokerage.jpg)

## Commercially Reasonable Procedure

A commercially reasonable procedure is a defensible, objective process for valuing terminated derivatives to ensure a fair and equitable settlement. </a><a href="https://prime.greeks.live/area/commercial-reasonableness/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A precision mechanism, potentially a component of a Crypto Derivatives OS, showcases intricate Market Microstructure for High-Fidelity Execution. Transparent elements suggest Price Discovery and Latent Liquidity within RFQ Protocols](https://options.greeks.live/wp-content/uploads/2025/07/prime-os-crypto-derivatives-rfq-engine-high-fidelity-execution.jpg)

## Commercial Reasonableness

Meaning ▴ Commercial Reasonableness, in the context of crypto institutional options trading and RFQ systems, signifies the objective standard by which the terms, conditions, and pricing of a transaction are evaluated for their alignment with prevailing market practices, economic rationality, and prudent business judgment among sophisticated participants. </a><a href="https://prime.greeks.live/area/good-faith/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A transparent blue sphere, symbolizing precise Price Discovery and Implied Volatility, is central to a layered Principal's Operational Framework. This structure facilitates High-Fidelity Execution and RFQ Protocol processing across diverse Aggregated Liquidity Pools, revealing the intricate Market Microstructure of Institutional Digital Asset Derivatives](https://options.greeks.live/wp-content/uploads/2025/07/digital-asset-derivatives-rfq-execution-system-microstructure-principal-framework.jpg)

## Good Faith

Meaning ▴ Good Faith, within the intricate and often trust-minimized architecture of crypto financial systems, denotes the principle of honest intent, fair dealing, and transparent conduct in all participant interactions and contractual agreements. </a><a href="https://prime.greeks.live/area/valuation-hierarchy/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A sleek, precision-engineered device with a split-screen interface displaying implied volatility and price discovery data for digital asset derivatives. This institutional grade module optimizes RFQ protocols, ensuring high-fidelity execution and capital efficiency within market microstructure for multi-leg spreads](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-protocol-execution-module.jpg)

## Valuation Hierarchy

Meaning ▴ Valuation Hierarchy refers to a structured framework that categorizes financial instruments and assets based on the observability and reliability of the inputs used in their valuation. </a><a href="https://prime.greeks.live/area/2002-isda/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![Wah Centre Hong Kong](https://options.greeks.live/wp-content/uploads/2025/08/Wah-Centre-Hong-Kong.jpg)

## 2002 Isda

Meaning ▴ The 2002 ISDA, or the 2002 ISDA Master Agreement, represents the prevailing global standard contractual framework developed by the International Swaps and Derivatives Association for documenting over-the-counter (OTC) derivatives transactions between two parties. </a><a href="https://prime.greeks.live/area/replacement-cost/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A symmetrical, angular mechanism with illuminated internal components against a dark background, abstractly representing a high-fidelity execution engine for institutional digital asset derivatives. This visualizes the market microstructure and algorithmic trading precision essential for RFQ protocols, multi-leg spread strategies, and atomic settlement within a Principal OS framework, ensuring capital efficiency](https://options.greeks.live/wp-content/uploads/2025/07/precision-execution-engine-for-institutional-digital-asset-derivatives-rfq.jpg)

## Replacement Cost

Meaning ▴ Replacement Cost, within the specialized financial architecture of crypto, denotes the total expenditure required to substitute an existing asset with a new asset of comparable utility, functionality, or equivalent current market value. </a><a href="https://prime.greeks.live/area/model-based-valuation/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![An abstract composition depicts a glowing green vector slicing through a segmented liquidity pool and principal's block. This visualizes high-fidelity execution and price discovery across market microstructure, optimizing RFQ protocols for institutional digital asset derivatives, minimizing slippage and latency](https://options.greeks.live/wp-content/uploads/2025/07/optimal-precise-digital-asset-derivative-rfq-execution-via-smart-protocols-for-institutional-trading.jpg)

## Model-Based Valuation

Meaning ▴ Model-Based Valuation is an analytical technique that employs quantitative models to ascertain the intrinsic or fair value of an asset, security, or business by projecting future financial metrics like cash flows or earnings. </a><a href="https://prime.greeks.live/area/early-termination-date/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A vibrant blue digital asset, encircled by a sleek metallic ring representing an RFQ protocol, emerges from a reflective Prime RFQ surface. This visualizes sophisticated market microstructure and high-fidelity execution within an institutional liquidity pool, ensuring optimal price discovery and capital efficiency](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-protocol-high-fidelity-execution-framework.jpg)

## Early Termination Date

Meaning ▴ An Early Termination Date refers to a specific, contractually defined point in time, prior to a financial instrument's scheduled maturity, at which the agreement can be concluded. </a><a href="https://prime.greeks.live/area/early-termination/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A meticulously engineered mechanism showcases a blue and grey striped block, representing a structured digital asset derivative, precisely engaged by a metallic tool. This setup illustrates high-fidelity execution within a controlled RFQ environment, optimizing block trade settlement and managing counterparty risk through robust market microstructure](https://options.greeks.live/wp-content/uploads/2025/08/precision-engineered-institutional-digital-asset-derivatives-rfq-execution.jpg)

## Early Termination

Meaning ▴ Early Termination, within the framework of crypto financial instruments, denotes the contractual right or obligation to conclude a derivative or lending agreement prior to its originally stipulated maturity date. </a><a href="https://prime.greeks.live/area/hedging-costs/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![A refined object, dark blue and beige, symbolizes an institutional-grade RFQ platform. Its metallic base with a central sensor embodies the Prime RFQ Intelligence Layer, enabling High-Fidelity Execution, Price Discovery, and efficient Liquidity Pool access for Digital Asset Derivatives within Market Microstructure](https://options.greeks.live/wp-content/uploads/2025/08/prime-os-rfq-protocols-for-digital-asset-derivatives-execution.jpg)

## Hedging Costs

Meaning ▴ Hedging Costs represent the aggregate expenses incurred by an investor or institution when implementing strategies designed to mitigate financial risk, particularly in volatile asset classes such as cryptocurrencies. </a><a href="https://prime.greeks.live/area/price-verification/?utm_source=options.greeks.live&utm_medium=referral&utm_campaign=satellite" class="glossary-item-box">
![Angular translucent teal structures intersect on a smooth base, reflecting light against a deep blue sphere. This embodies RFQ Protocol architecture, symbolizing High-Fidelity Execution for Digital Asset Derivatives](https://options.greeks.live/wp-content/uploads/2025/07/dynamic-rfq-protocol-architecture-optimizing-digital-asset-derivative-liquidity-aggregation.jpg)

## Price Verification

Meaning ▴ Price verification is the process of confirming the accuracy and fairness of a financial instrument's quoted or executed price against independent sources or established market benchmarks. </a>

**Tags:** [Model-Based Valuation](https://options.greeks.live/area/model-based-valuation/), [Valuation Hierarchy](https://options.greeks.live/area/valuation-hierarchy/), [2002 ISDA Master Agreement](https://options.greeks.live/area/2002-isda-master-agreement/), [Early Termination](https://options.greeks.live/area/early-termination/), [Bankruptcy Code Section 562](https://options.greeks.live/area/bankruptcy-code-section-562/), [Commercial Reasonableness](https://options.greeks.live/area/commercial-reasonableness/)	

## Discover More

- 
### [What Legal Challenges Can Arise When Determining a Commercially Reasonable Close out Amount?](https://options.greeks.live/question/what-legal-challenges-can-arise-when-determining-a-commercially-reasonable-close-out-amount/)
![A sophisticated, illuminated device representing an Institutional Grade Prime RFQ for Digital Asset Derivatives. Its glowing interface indicates active RFQ protocol execution, displaying high-fidelity execution status and price discovery for block trades. The design suggests robust market microstructure and capital efficiency.](https://options.greeks.live/wp-content/uploads/2025/07/principal-rfq-engine-for-digital-asset-derivatives-best-execution-1.jpg)

Navigating close-out amounts requires a precise, objective, and legally defensible valuation process.

- 
### [How Do Courts Treat Close-Out Calculations in Illiquid Market Conditions?](https://options.greeks.live/question/how-do-courts-treat-close-out-calculations-in-illiquid-market-conditions/)
![A stylized spherical system, symbolizing an institutional digital asset derivative, rests on a robust Prime RFQ base. Its dark core represents a deep liquidity pool for algorithmic trading. A blue band signifies high-fidelity execution protocols, ensuring optimal price discovery and capital efficiency within market microstructure, enhancing alpha generation.](https://options.greeks.live/wp-content/uploads/2025/08/institutional-grade-rfq-protocol-engine-facilitating-best-execution-and-liquidity-aggregation-for-digital-asset-derivatives.jpg)

Courts require an objectively defensible process for derivative close-outs in illiquid markets, making your firm's valuation architecture the primary evidence.

- 
### [What Are the Primary Legal Recourses under an ISDA Master Agreement during a Default?](https://options.greeks.live/question/what-are-the-primary-legal-recourses-under-an-isda-master-agreement-during-a-default/)
![Intersecting concrete structures symbolize the robust Market Microstructure underpinning Institutional Grade Digital Asset Derivatives. Dynamic spheres represent Liquidity Pools and Implied Volatility. A sophisticated cylindrical Crypto Derivatives OS facilitates High-Fidelity Execution through RFQ protocols, enabling Block Trade and Multi-Leg Spread strategies, ensuring Capital Efficiency.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-framework-optimizing-rfq-execution-and-liquidity-for-principal-trading.jpg)

Upon default, the ISDA framework enables the non-defaulting party to terminate all transactions and crystallize a single net payment obligation.

- 
### [How Do Courts Interpret “Commercially Reasonable Procedures” in Close-Out Amount Calculations?](https://options.greeks.live/question/how-do-courts-interpret-commercially-reasonable-procedures-in-close-out-amount-calculations/)
![Angular dark planes frame luminous turquoise pathways converging centrally. This visualizes institutional digital asset derivatives market microstructure, highlighting RFQ protocols for private quotation and high-fidelity execution. The central convergence point represents price discovery and atomic settlement within a prime brokerage framework, optimizing capital efficiency.](https://options.greeks.live/wp-content/uploads/2025/07/high-fidelity-rfq-protocols-for-institutional-digital-assets.jpg)

Courts interpret "commercially reasonable procedures" as an objective, evidence-based standard for valuing derivative close-outs.

- 
### [Why Was the Close-Out Amount a Significant Change in the 2002 ISDA?](https://options.greeks.live/question/why-was-the-close-out-amount-a-significant-change-in-the-2002-isda/)
![A macro view reveals the intricate mechanical core of an institutional-grade system, symbolizing the market microstructure of digital asset derivatives trading. Interlocking components and a precision gear suggest high-fidelity execution and algorithmic trading within an RFQ protocol framework, enabling price discovery and liquidity aggregation for multi-leg spreads on a Prime RFQ.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-execution-system-precision-engine.jpg)

The 2002 ISDA's Close-Out Amount replaced a flawed, rigid valuation system with a flexible, commercially reasonable standard.

- 
### [How Does the 2002 ISDA Close-Out Amount Standard Reduce Legal Risk?](https://options.greeks.live/question/how-does-the-2002-isda-close-out-amount-standard-reduce-legal-risk/)
![A complex, multi-layered electronic component with a central connector and fine metallic probes. This represents a critical Prime RFQ module for institutional digital asset derivatives trading, enabling high-fidelity execution of RFQ protocols, price discovery, and atomic settlement for multi-leg spreads with minimal latency.](https://options.greeks.live/wp-content/uploads/2025/08/institutional-digital-asset-rfq-engine-driving-best-execution-and-liquidity.jpg)

The 2002 ISDA Close-out Amount standard reduces legal risk by replacing rigid, brittle valuation rules with a flexible, yet objectively defensible, framework.

- 
### [What Are the Primary Grounds for Disputing a Close out Amount Calculated by an Internal Model?](https://options.greeks.live/question/what-are-the-primary-grounds-for-disputing-a-close-out-amount-calculated-by-an-internal-model/)
![A sophisticated institutional-grade system's internal mechanics. A central metallic wheel, symbolizing an algorithmic trading engine, sits above glossy surfaces with luminous data pathways and execution triggers. This abstract visualizes high-fidelity execution for digital asset derivatives, optimizing market microstructure and RFQ protocol efficiency within a Prime RFQ.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-rfq-execution-engine-core.jpg)

Grounds for disputing a close-out amount center on failures of the calculation to be commercially reasonable in procedure and result.

- 
### [How Does the Close out Calculation Differ between the 1992 and 2002 Isda Agreements?](https://options.greeks.live/question/how-does-the-close-out-calculation-differ-between-the-1992-and-2002-isda-agreements/)
![A central, dynamic, multi-bladed mechanism visualizes Algorithmic Trading engines and Price Discovery for Digital Asset Derivatives. Flanked by sleek forms signifying Latent Liquidity and Capital Efficiency, it illustrates High-Fidelity Execution via RFQ Protocols within an Institutional Grade framework, minimizing Slippage.](https://options.greeks.live/wp-content/uploads/2025/07/institutional-digital-asset-derivatives-market-microstructure-rfq-protocol-optimization.jpg)

The 2002 ISDA Agreement replaces the rigid 1992 'Market Quotation/Loss' with a flexible 'Close-out Amount' based on commercial reasonableness.

- 
### [In What Ways Can the Valuation of Terminated Derivatives Be Disputed during a Default?](https://options.greeks.live/question/in-what-ways-can-the-valuation-of-terminated-derivatives-be-disputed-during-a-default/)
![A meticulously engineered mechanism showcases a blue and grey striped block, representing a structured digital asset derivative, precisely engaged by a metallic tool. This setup illustrates high-fidelity execution within a controlled RFQ environment, optimizing block trade settlement and managing counterparty risk through robust market microstructure. It highlights a Prime RFQ intelligence layer.](https://options.greeks.live/wp-content/uploads/2025/08/precision-engineered-institutional-digital-asset-derivatives-rfq-execution.jpg)

Disputing a terminated derivative's value involves a forensic audit of the close-out process and its commercial reasonableness.

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            "name": "What Is The Role Of Good Faith?",
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                "text": "A critical element of the strategy is understanding the interplay between \"good faith\" and \"commercially reasonable procedures.\" They are intertwined obligations. Good faith is a subjective standard, relating to the state of mind and intentions of the calculating party\u2014it is a duty to act honestly. Commercial reasonableness, conversely, is an objective standard. It assesses the actions taken against the norms and practices of participants in the relevant market. A strategy cannot rely on good faith alone. A party could honestly believe its valuation is correct, but if the procedure used to arrive at that valuation deviates from standard market practices without justification, it would fail the commercial reasonableness test. The strategy must therefore be to ensure that every step of the process is not only performed honestly but is also aligned with what a reasonable market participant would do in similar circumstances."
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                "text": "The following table illustrates a sample log for the inputs used to value a hypothetical 10-year US Dollar interest rate swap that has been terminated."
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                "text": "When a counterparty enters bankruptcy, the execution of the valuation process is subject to additional legal constraints and scrutiny, primarily under the U.S. Bankruptcy Code. Section 562 establishes the timing for measuring damages from a terminated swap agreement. Damages are to be measured as of the date of termination. However, the statute provides a critical exception: if there are no \"commercially reasonable determinants of value\" on that date, damages are measured on the first subsequent date where such determinants exist. This provision places an immense burden of proof on the party that performed the valuation. If a debtor or trustee challenges the valuation date, the non-defaulting party must be able to prove, using evidence like the quote solicitation record, that it was impossible to obtain a reliable value on the termination date. This makes the disciplined execution of the operational playbook and the meticulous documentation of every failed attempt to get a price absolutely critical for defending the valuation in court."
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}
```


---

**Original URL:** https://options.greeks.live/question/what-constitutes-a-commercially-reasonable-procedure-for-valuing-a-terminated-derivative/
